Chancellor Rachel Reeves is set to present the 2025 Autumn Budget on 26 November that could rank among the most significant in recent years, as she faces the challenge of rebuilding fiscal credibility while balancing political commitments and fostering growth amid a tough economic backdrop.

Why is the Chancellor facing another huge fiscal hole? 

It was only a year ago that media headlines claimed the Chancellor had inherited a £22bn “black hole” in the public finances from the previous government - and here we are again. How can we be facing a larger black hole now? 

Media suggests that the Office for Budget Responsibility (OBR), the UK’s fiscal watchdog, has downgraded its UK trend productivity growth forecast. In addition, the government will need to raise another £6bn to cover policy U-turns on welfare reforms and winter fuel payment cuts since the Spring Statement in March. Recent reports put the fiscal hole close to £20bn, which is lower than earlier estimates of £20–30bn.

However, we expect the Chancellor to offer some “sweeteners”, such as scrapping the two-child benefit cap and removing VAT on energy bills, both costing around £2.5bn. Finally, we expect the Chancellor will want to increase the fiscal headroom (the buffer between current spending plans and the limits imposed by fiscal rules) by approximately £5bn to bring it closer to £15bn. While there are many moving parts in the fiscal headroom calculations, these rough estimates point to around £30bn needing to be funded.

How to fill the hole?

Given the Chancellor has repeatedly stressed that the fiscal rules are ‘iron-clad’, breaking or loosening the rules looks unlikely, so the Chancellor will have to ‘fill’ the hole via tax changes rather than spending cuts. We think there is little political will for large scale spending cuts, hence the majority of the government’s shortfall will need to be financed via higher taxes.

With a black hole as large as the current one, the easiest way to rebuild headroom would be to break one of the government’s manifesto pledges not to raise taxes on “working people”- i.e., not increasing National Insurance, the basic, higher, or additional rates of Income Tax, or VAT. Until last week, it looked very likely that the Chancellor would raise income tax, possibly by 2p. If applied across all three bands, this could raise just over £20bn. However, the most recent reports suggest the Chancellor has scrapped plans to increase income tax and will instead introduce a “smorgasbord” of smaller tax changes, as well as freezing income tax thresholds for two more years, which would raise about £10.4bn.

But a series of smaller tax increases will still need to do a lot of heavy lifting to fund the remaining £20bn, such as a higher rate of council tax on G and H properties, a pay-per-mile tax on electric vehicles, and gambling tax reform.

What would make a good Budget from a gilt investor’s point of view?  

Until last week, the gilt market had a tremendous October and November: yields were down 25-30 bps across the curve, outperforming peers. These moves were attributed to more favourable economic data, particularly on inflation and wages, which increased the probability of Bank Rate cuts, as well as “market-friendly” government commentary about the upcoming Budget.

However, the Chancellor’s income tax U-turn saw gilt yields rise 10–15 bps as nervousness grew among investors about the government’s commitment to fiscal discipline, its willingness to make ‘tough choices,’ and the possibility of further political volatility. All taxes hit economic activity, but the effects of changes to income tax are generally predictable. Outsized changes to many other taxes can lead to outsized economic effects, unintended consequences, and ultimately policy U-turns.

We have identified six points that would constitute a “good Budget” from a gilt investor’s perspective and assess how we believe the Chancellor is faring:

1. Fiscal rules need to be met; headroom restored at £9.9bn or possibly increased. The Chancellor has repeatedly said the fiscal rules are "iron-clad," so the belief is that headroom will at least be maintained at £9.9bn. However, the refusal to increase income tax suggests that the headroom will not be meaningfully increased.
2. Issuance in the current fiscal year and across the forecast horizon should not rise meaningfully. The Chancellor noted that higher issuance comes with higher costs and that government debt-servicing costs are too high. Given one of her three Budget pillars is reducing debt-to-GDP, we do not expect issuance to rise significantly.
3. The OBR's reduction in productivity assumptions - and hence GDP growth forecasts -should be seen as credible. All indications are that the OBR is reducing its productivity forecasts, bringing its economic growth predictions more in line with other forecasters.
4. Measures undertaken should not be seen as inflationary. Another of the Chancellor's Budget pillars is reducing the cost of living. Hence, it would be strange to increase VAT. Indeed, we think the Budget is more likely to lower inflation than raise it, with the possible scrapping of VAT on energy bills.
5. Revenue-raising measures need to be seen as credible and not entirely back-loaded. The Budget will look more credible if most of the gap is filled by tax rises now, rather than delaying tough spending cuts for later. However, by relying on multiple tweaks and novel changes to the tax system instead of income tax rises, this may increase complexity and result in a larger share of the overall tax burden being shifted to businesses.
6. The Budget announcements should boost political stability. Unfortunately a politically popular and gilt-friendly Budget is a circle that is hard to square. Although a manifesto breach is likely to be avoided, the new measures could still leave Chancellor Reeves and PM Starmer vulnerable.

Ultimately, the Chancellor will be hoping her Budget paves the way for faster Bank Rate cuts by the Bank of England next year, creating a more structurally positive story into the second half of the parliament.